Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Activision Blizzard (NASDAQ:ATVI)

Q3 2013 Earnings Call

November 06, 2013 4:30 pm ET

Executives

Kristin Mulvihill Southey - Former Vice President of Investor Relations

Robert A. Kotick - Chief Executive Officer, President and Director

Dennis Durkin - Chief Financial Officer

Eric Hirshberg - Chief Executive Officer of Activision Publishing, Inc

Michael Morhaime - Chief Executive Officer of Blizzard Entertainment, Inc and President Blizzard Entertainment, Inc

Analysts

Brian J. Pitz - Jefferies LLC, Research Division

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

Douglas Creutz - Cowen and Company, LLC, Research Division

Avi Steiner - JP Morgan Chase & Co, Research Division

Edward S. Williams - BMO Capital Markets U.S.

Eric James Sheridan - UBS Investment Bank, Research Division

Operator

Good day, and welcome to the Activision Blizzard's Q3 2013 Results Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn today's call over to Senior Vice President of Investor Relations, Ms. Kristin Southey. Please go ahead, Kristin.

Kristin Mulvihill Southey

Good afternoon, and thank you for joining us today for Activision Blizzard's third quarter 2013 conference call. With me today are Bobby Kotick, CEO of Activision Blizzard; Thomas Tippl, COO of Activision Blizzard; Dennis Durkin, CFO of Activision Blizzard; Eric Hirshberg, CEO of Activision Publishing; and Mike Morhaime, CEO of Blizzard Entertainment.

I would like to remind everyone that during this call, we will be making statements that are not historical facts. These are forward-looking statements that are based on current expectations and assumptions that are subject to risks and uncertainties.

As indicated on the slide that is showing, a number of important factors that could cause the company's actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements. Such factors include, but are not limited to: sales levels of Activision Blizzard's titles; the impact of the current macroeconomic environment; increasing concentration of titles; shifts in consumer spending trends; Activision Blizzard's ability to predict consumer preferences, including interest in specific genres such as first-person action, Toys to Life, and massively multiplayer online games, and preferences among competing hardware platforms; maintenance of relationships with key personnel, customers, licensees, licensors, vendors and third-party developers, including the ability to attract, retain and develop key personnel and developers that can create high-quality titles; the seasonal and cyclical nature of the interactive entertainment market; changing business models, including digital delivery of content; competition, including from used games and other forms of entertainment; possible declines in software pricing; product returns and price protection; product delays; adoption rate and availability of new hardware, including peripherals, and related software, particularly during the ongoing console transition; rapid changes in technology and industry standards; the current regulatory environment; litigation risks and associated costs; protection of our proprietary rights; counterparty risks relating to customers, licensees, licensors and manufacturers; domestic and international economic, financial and political conditions and policies; foreign exchange rates and tax rates; potential challenges associated with geographic expansion; the possibility that expected benefits related to the recently completed transactions with Vivendi may not materialize as expected; the amount of our debt and the limitations imposed by the covenants in the agreements governing our debt; and the other factors identified in the Risk Factors section of Activision Blizzard's most recent annual report on Form 10-K, as amended, and our quarterly report on Form 10-Q for the quarter ended September 30, 2013.

These important factors and other factors that potentially could affect the company's financial results are described in the company's most recent annual report on Form 10-K, as amended, our quarterly report on Form 10-Q for the period and other filings with the SEC. The company may change its intentions, beliefs or expectations made at any time and without notice based upon any changes in such factors in the company's assumptions or otherwise.

The forward-looking statements in this presentation are based on information available to the company as of the date of this presentation and while we believe them to be true, they ultimately may prove to be incorrect. The company undertakes no obligation to release publicly any revision to any forward-looking statement to reflect events or circumstances after today, November 6, 2013, or to reflect the occurrence of unanticipated events.

I'd like to note that certain numbers we will be presenting today will be made on a non-GAAP basis, excluding the impact of the change in deferred net revenues and related cost of sales with respect to certain of our online-enabled games; expenses related to stock-based compensation; the amortization of intangible assets; expenses relating to the purchase transaction and related debt financing; and the associated tax benefit. Please refer to our earnings release, which is posted at www.activisionblizzard.com for a full GAAP to non-GAAP reconciliation and further explanation.

There's also a PowerPoint overview, which you can access with the webcast and which will be posted to the website following the call. In addition, we will also be posting a 12-quarter financial overview highlighting both GAAP and non-GAAP results and a 1-page summary sheet. This quarter, we have also added a number of EBITDA metrics to our earnings release and slides for our new debt investors and analysts.

And now I'd like to introduce Bobby Kotick, our CEO.

Robert A. Kotick

Thank you, Kristin, and welcome, everyone. Today, we're hosting our earnings call as an independent public company for the first time in 5 years. As of October 11, the majority of our shares are now held by public shareholders. The transaction we completed on October 11 is representative of the focused approach to creating shareholder value that we've employed for more than 2 decades.

As you'll hear in detail today, there are immediate benefits to our shareholders in the form of earnings per share accretion, and most importantly, our transaction provides the strategic and operational independence we need to drive long-term stakeholder value. The management team is more energized and empowered than ever, and we remain committed to generating long-term superior returns and effectively managing our capital structure.

Our return to independence could not come at a more important time. This month, Sony and Microsoft will launch new consoles for the first time in more than 7 years. These consoles will enable our games to be even better, richer, more immersive, more engaging and more entertaining. PC games like Diablo III have established new records for sales and for engagement, and tablets and mobile devices are now starting to provide opportunities to create differentiated and compelling new types of games and access to new audiences and new geographies. All of these trends are resulting in larger audiences around the world for games.

Platform transitions have always presented great opportunities, as well as short-term challenges. We're well prepared to capitalize on these new opportunities, and we've been very adept at managing through the risks of hardware and business model transitions for over 22 years.

Our industry-leading capabilities embodied in the most talented group of employees in all of video games have enabled us to create the very best interactive content across varied platforms and varied business models, always with the ability to prioritize these investments against the opportunities that will provide the highest returns to our stakeholders. And we continue to, of course, establish new bars for creative excellence.

While our focus is always on the long term, we did have another quarter with better-than-expected financial results as a result of the continued success of our most popular games. Call of Duty generated record results both in Q3 and for the year-to-date, and we shipped over $1 billion of Call of Duty: Ghosts to retailers around the world.

Call of Duty as a franchise remains incredibly high -- with high levels of engagement, and in fact, Q3 was a record high for Call of Duty franchise engagement. Skylanders remains the #1 kids video game franchise year-to-date and has generated over $1.5 billion in sell-through life-to-date, including toys and accessories. World of Warcraft remains the world's #1 subscription-based MMORPG and ended the quarter with approximately 7.6 million subscribers. And Diablo III, the world's best-selling PC action RPG, was the first Blizzard franchise to be made available to console players in more than a decade.

In a year with many market challenges, our performance for the quarter and first 9 months of 2013 has been strong, and today, we are increasing our calendar year outlook.

Despite short-term uncertainties, as we look forward to 2014, we have a very strong product pipeline. We expect multiple new releases across our major franchises, including the first Diablo III expansion, Reaper of Souls, along with the PS4 version of Diablo III and significant and exciting new content for World of Warcraft.

We also expect to launch new Call of Duty and Skylanders titles and a major new potential franchise with Bungie's Destiny. We're also continuing to develop Call of Duty Online in partnership with Tencent for the large and growing Chinese market and Blizzard's Heroes of the Storm.

Because of our industry-leading talent, technology, scale, focused management team and deep financial resources, we are well positioned for long-term sustained success. In the coming year, we'll continue to invest prudently to build world-class entertainment franchises, broaden our leadership position and expand our global footprint. As an independent company, we have a strong foundation to take advantage of a variety of future opportunities and to remain focused on generating strong cash flow and delivering superior returns to all of our stakeholders.

And now Dennis will review our results and our outlook.

Dennis Durkin

Thanks, Bobby. Good afternoon, everyone. Today, I will start with a brief recap of the Vivendi transaction, followed by a review of our better-than-expected September quarterly results and our increased outlook for the full year.

On October 11, just after the end of the quarter, Activision Blizzard closed our share purchase and recapitalization transaction with Vivendi. On that date, Activision Blizzard brought back approximately 429 million shares or around 38% of our outstanding shares for $13.60 per share in cash, reflecting a 20% discount to the October 11 closing price of $17.08. Activision Blizzard funded the deal, including transaction fees and upfront interest, with approximately $1.2 billion of balance sheet cash and $4.75 billion of newly issued debt. Our financing included $2.5 billion of 7-year bank debt, $1.5 billion of 8-year notes and $750 million of 10-year notes. In addition, we established a $250 million revolving credit facility, which was undrawn at closing.

All in, our weighted average interest rate came in at the low end of our August estimate at just less than 5%. On closing, the company paid Vivendi approximately 5.83 billion shares for the shares that were repurchased, which left us with more than $3 billion in cash on hand, approximately $500 million of which is held domestically. This significant cash balance helps secure our future financial stability. Going forward, we believe that our free cash flow generation will support the debt we have while also allowing us the flexibility to continue to invest in our business and drive value for all of our stakeholders over time.

So all in, we had a very solid execution and closing at favorable financing rates a shareholder-friendly transaction. I'd like to thank both our internal teams and our external advisors for their tireless efforts in getting this deal over the goal line. It is nice to, once again, be an independent company with a newly optimized capital structure, a lower weighted average cost of capital and a higher return on equity for our shareholders.

Now let's turn to business and our better-than-expected Q3 results. Please refer to our earnings release for full GAAP to non-GAAP reconciliations. For the third quarter, on a GAAP basis, we generated revenues of $691 million, including a record 59% of revenues from digital channels, and operating margin of 10% and EPS of $0.05. On a non-GAAP basis for the quarter, we generated revenues of $657 million, with 61% of revenues coming from digital channels. We generated an adjusted EBITDA margin of 22%, with adjusted EBITDA being defined as non-GAAP operating income before depreciation. We also delivered an operating margin of 19% and EPS of $0.08.

Revenues in the quarter were driven by Activision Publishing's Call of Duty and Skylanders and Blizzard Entertainment's World of Warcraft and the launch of Diablo III on consoles. As expected, our results were below last year, when we had the Q3 launch of the World of Warcraft: Mists of Pandaria expansion pack and continued sell-through of Diablo III on PC.

Turning to the specific P&L items. Please note that all percentages are based on revenues, except for the tax rate.

For GAAP in Q3, product costs were 22%, better than expected due to higher digital revenues. Total operating expenses were 68%, in line with our outlook as higher revenues offset transaction costs in the quarter, which totaled $62 million. Interest expense was $4 million for both GAAP and non-GAAP.

Our GAAP tax rate was 15% below our outlook due to the transaction costs I just mentioned. For non-GAAP in Q3, product costs were 24% and operating expenses were 57%, both better than expected on higher revenues. Our non-GAAP tax rate was 28%, roughly in line with expectations.

In terms of cash flow for the trailing 12 months ending September 30, our operating cash flow was $1.36 billion. And less capital expenditures, our free cash flow was $1.28 billion, which comes after making significant investments in our multiyear pipeline and back-end infrastructure.

Turning to the balance sheet. Given the transaction did not close by quarter end, we had not fully funded our financing. The $2.25 billion of 8- and 10-year notes had priced and funded in mid-September but were held in escrow pending closing of the deal. The $2.5 billion of bank debt had not yet been funded at quarter end. So the note proceeds, interest and some associated fees totaling $2.3 billion were held as cash in escrow and are the only part of the financing which shows up on our September balance sheet.

Following the closing of the transaction on October 11, we had total debt of $4.75 billion and approximately $3.4 billion in cash and investments, net of the $1.2 billion that was paid out at closing. With trailing 12-month adjusted EBITDA of $1.74 billion, our total gross debt to trailing 12-month adjusted EBITDA was 2.7x. And importantly, our net debt to trailing EBITDA -- adjusted EBITDA was approximately 0.8x.

Now let's turn to our 2013 full year outlook. As we have said for more than a year now, console transition years are volatile and hard to predict, and this year is proving no different. In spite of this backdrop and based on our solid performance year-to-date, we are raising our full year outlook for the year. However, we still remain cautious for the fourth quarter. Today, we announced that we had shipped into retail more than $1 billion of Call of Duty: Ghosts globally on day 1 based on an average wholesale price.

As expected, due to the console transition and digital distribution, this number is down versus last year. This year, the sell-through curve will be different than in past years due to the multiple launches of new hardware later in the month and more days between our launch and the high-volume Black Friday at the end of the month. That said, it's a very solid achievement and shows the tremendous confidence our retail partners have and the strength of the game and franchise heading into this holiday.

So let's walk through the numbers. For 2013, on a GAAP basis, we expect net revenues of $4.32 billion, product costs of 23% and operating expenses of 49%. We expect interest of $58 million, a full year tax rate of 23% and a fully diluted weighted average share count of 1.06 billion, which is higher than our prior outlook given the transaction closed on October 11 instead of September 30. For the calendar year, we are raising our full year GAAP EPS outlook to $0.83.

On a non-GAAP basis, we expect net revenues of $4.285 billion, product costs of 26% and operating expenses of 43%. We expect an operating margin of 31%, interest expense of $58 million, a full year tax rate of 25% and the same higher share count as GAAP. We are also increasing our non-GAAP EPS outlook to $0.89, about $0.03 higher than the high end of our previous estimate, partially offset by the increased share count.

In the December quarter, on a GAAP basis, we expect net revenues of $1.255 billion, product costs of 23%, operating expenses of 69% and an operating margin of 8%. We expect interest expense of $54 million and a GAAP tax rate of 23%. We expect a share count of 785 million, up from our prior outlook of 743 million due to the delayed closing. We are also raising our GAAP EPS outlook to $0.05.

For the December quarter, on a non-GAAP basis, we expect net revenues of $2.215 billion, product costs of 27% and operating expenses of 36%, which is higher than our previous outlook due in part to increased marketing investment for our franchise launches. We expect an operating margin of 37%, interest expense of $54 million, a non-GAAP tax rate of 25% and a higher share count of 785 million. The impact of the higher share count is approximately $0.04, and we now expect non-GAAP EPS of $0.72 in the quarter.

On a pro forma basis, assuming the transaction took effect January 1, 2013, our full year GAAP EPS would be $1.06 and our full year non-GAAP EPS outlook would be $1.16. The significant accretion, which came in above our range, reflects a 38% reduction in our fully diluted shares outstanding, partly offset by approximately $220 million in incremental pretax interest expense associated with the new debt.

Looking ahead, in spite of a challenging and volatile 2013 and with our transaction closed and behind us, we are excited about the future and the new and innovative experiences we are building for our global customers. In 2014, we plan to continue delivering innovation and quality in our slate, to continue expanding our retail and digital presence and to continue focusing on costs and maintaining strong credit quality. In 2014, we have a bigger slate planned as compared to 2013, with multiple Blizzard titles, Destiny and new Call of Duty and Skylanders games.

We will also be entering the second year of the new console cycle, which will enable more digital opportunities for us to connect even more deeply with our players. We look forward to sharing more details about our 2014 plans and outlook, as we always do, in February, following completion of the 2013 holiday season and our annual operating plan in January.

Now I'll turn the call over to Eric Hirshberg to discuss Activision Publishing.

Eric Hirshberg

Thanks, Dennis. I'll start with a quick recap of our Q3 performance, and then I'll discuss current industry dynamics, our slate and our pipeline. I'm pleased to announce that Activision Publishing produced a record Q3 and year-to-date performance in terms of operating income. I want to thank our tremendously talented and passionate employees who continually find ways to deliver best-in-class execution and record results, even during a challenging console transition year.

Today, market fundamentals are mixed. Demand for many annualized AAA titles are down as consumers continue to show hesitation ahead of the launch of next-gen consoles. In fact, some games based on top-selling franchises are significantly down versus last year. While we don't expect to be immune to these industry-wide patterns and while we expect the sales curve to be shaped differently this year given the mid-quarter launch of next-gen consoles and the fact that Black Friday is later this year, we also know that purchase intent and awareness for our key titles are strong. We're also seeing increased supply and demand for next-gen consoles, and we believe consumers will reward those who have breakthrough next-gen games ready at launch, and we do.

Historically, following console transitions, the top franchises have emerged stronger than when they entered the cycle. We believe that our 2 top 5 franchises, Call of Duty and Skylanders, are well positioned and will emerge stronger over the long term. For both Call of Duty and for Skylanders, one of the keys to our success has been our ability to keep players engaged with new content all-year long.

Year-to-date, Call of Duty digital revenues set new franchise records. The franchise also set a new record for online engagement with over 4 billion hours played online. Put simply, players are spending more of their time and money online with Call of Duty than ever before.

In fact, in the last 12 months, Black Ops II, including digital sales, has generated more revenue than any other console game ever has in a single year. If you took Black Ops II digital revenue alone this year and judge it as a standalone game, it would be the third largest game at retail this year, behind only GTA V and Skylanders Giants, including toys and accessories.

Call of Duty has long had the largest and most engaged console player base in the industry. We now offer multiple ways for our players to stay engaged with the game, including à la carte DLC packs, micro DLC and Season Pass, and these additions have proven to have value to our players. And they have transformed our revenues from a simple equation of units times price to the equation of players times revenue per player. By providing tremendous value and variety to our players, we are now able to monetize play all year round better than ever before, and our record digital revenues this year proved that out.

Yesterday, we launched our new Call of Duty game, Call of Duty: Ghosts. And the game launched at a time that the franchise has never been more popular. We have 15,000 midnight openings around the world, and while it's too early to assess sell-through, we have sold more than $1 billion of Call of Duty: Ghosts into retail stores worldwide already. Call of Duty: Ghosts has moved quickly into the #1 spot as the most played game on Xbox LIVE, and millions of people are already playing Call of Duty: Ghosts online and loving the game.

On the Xbox 360, we're seeing average player sessions for Ghosts which have been longer than either Black Ops II or Call of Duty: Modern Warfare 3 during the same time period. Ghosts is a great game. It has an amazing and diverse single-player campaign, meaningful innovation to the genre's most played and most beloved multiplayer game and an innovative and deep new third mode called Extinction.

Ghosts offers more variety and depth of gameplay on the disc than any competitive offering in the genre. For Call of Duty: Ghosts, we once again plan on offering a compelling array of digital items that will let players personalize their game experience like never before. Also, Call of Duty: Ghosts will be available via digital download on Xbox 1 and PS4 on the same day that it's available in stores. So fans can get the game where they want and how they want.

For gamers who plan to purchase the next-gen console but want to start playing now, we're offering seamless upgrade programs at both Microsoft and Sony, as well as selected retail partners. For a limited time fans can purchase Call of Duty: Ghosts for their current console and then download the next-gen version of the game within the same console family for just $10 whenever they're ready. When they get their new console, they'll be able to -- they will be a step ahead both by having learned the mass and by having all their player achievements migrate with them into the next-gen game.

We're excited about yesterday's launch, but it's obviously still very early. We've had great support from our retail partners, and the game looks and plays incredibly well on both the current and next-gen systems.

Now turning to our second billion-dollar franchise, Skylanders.

Skylanders breakthrough concept of bringing Toys to Life has redefined kids video games and collectible toys and established an entirely new genre of play. Innovation and quality are at the heart of the franchise's success, and I want to thank Vicarious Visions for delivering the most innovative and highest-rated Skylanders game yet, with Skylanders SWAP Force.

Skylanders SWAP Force launched on October 13 with awareness and purchase intent that have never been higher. Consistent with other annualized AAA titles, initial sell-through is down in this console transition year versus last year. We believe demand remains strong but expect a different-shaped sell-through curve than we saw last year.

We're just entering the holiday shopping season. Our next-gen launches and majority of our sell-through are still ahead of us. But we're taking nothing for granted, which is why we are investing in the largest marketing and retail campaign in the franchise's history, with over 20% more shelf space from our retail partners and more media presence than ever before. With a great game, high awareness and purchase intent, strong retail partnerships and focused execution, we plan to enhance our leadership for now and for the years ahead.

So to summarize, Activision Publishing delivered a record Q3 and a record year-to-date. While overall industry dynamics remain challenging, we're confident in the quality of our games, the quality and scale of our launch plans, and we have the best go-to-market execution in our history.

Looking forward to 2014, we plan to release new games based on Call of Duty and Skylanders, as well as Destiny, the only universe from Bungie. Reception for Destiny at Gamescom was incredible. All told, Destiny has received about 75 awards, including Best of Show, at Gamescom and is on track to achieve the most preorders of any new IP in history.

Our goal is to establish a new intellectual property for the next 10 years, and we're making substantial investments in both product development and marketing. The game looks amazing on both current and next-gen consoles, and most importantly, it's just a lot of fun. We're very excited about the upcoming beta in 2014, and we can't wait for you to have a chance to play it for yourselves.

As you know, we're also working with Tencent to bring Call of Duty Online to the massive Chinese online market. The game is looking great. We look forward to sharing more details about our plans with you in the future.

In the coming year, we will keep our focus exactly where it has been, on delivering breakthrough innovation and genre-leading quality with every game we launch. We believe that our focused strategy of delivering AAA titles to drive year-round engagement is working. This strategy has served us very well in the past and we believe will position us for long-term success in the future.

And now I'll turn it over to Mike Morhaime for an update on Blizzard.

Michael Morhaime

Thank you, Eric. Q3 was an eventful quarter for Blizzard. We launched our first console game in many years with Diablo III. We also announced an expansion pack for Diablo III, Reaper of Souls. Additionally, beta testing for Hearthstone kicked off, and we released a significant new content update for World of Warcraft. All of this activity has netted out to a strong quarter, where we ended higher in net revenue and operating income versus Q2 mostly due to the Diablo III console launch in September. Revenues and income were down year-over-year, as expected, due to the successful launch of Mists of Pandaria and ongoing sales of Diablo III during the same quarter last year.

Going into more specific detail with World of Warcraft, we're very pleased with the response to Siege of Orgrimmar, the massive content update we released in September. This update included a huge new raid dungeon with major story elements, as well as a new area to explore and features that improved the game's accessibility. Flexible rates now allow groups of variable size to participate in the endgame raiding dungeons.

Meanwhile, the proving grounds feature trains players to improve at playing specific roles, preparing them to participate in endgame content. Player response to the content has been good, and we saw increased engagement that has contributed to maintaining relatively stable subscribership quarter-over-quarter. We'll continue to invest heavily in World of Warcraft to deliver frequent, high-quality content to our players.

Moving on to Diablo III, we're pleased with the response to the game's launch on PlayStation 3 and Xbox 360. Lifetime sell-through of the game across all platforms has reached over 14 million copies, and reviews have been very positive about how the game plays on console. Much of the praise has been centered on changes we made to the loot system and our decision to keep the auction house off of the console platform. Players and critics alike have noted that these changes have resulted in a more fun and satisfying game experience. That reaction factored in our decision to remove the auction houses from the PC version of Diablo III effective next March, which players have also responded very positively to.

We're building upon those design philosophies for loot and incorporating them into Reaper of Souls, the Diablo III expansion pack which is coming for PC and PS4 in 2014. In addition to the new loot system, Reaper of Souls will include an additional player class, the Crusader, and more gameplay modes for the endgame to keep players engaged. The reaction to Reaper of Souls at Gamescom was very positive, and we're looking forward to revealing more about the game at BlizzCon.

It was also a busy quarter for Hearthstone, our free-to-play digital card game for PC and iPad based on the Warcraft universe. In Hearthstone, players build decks of cards that feature familiar spells and creatures from World of Warcraft and battle against each other using the cards. Players can collect cards simply by playing or by purchasing digital packs. They can also purchase entries into a special competitive mode of play called The Arena in exchange for either in-game currency or a small fee.

We've seen a great response from the community with the closed beta test, which kicked off in August. Hearthstone quickly became one of the most popular streamed games on Twitch, and we have been expanding the beta test to encompass more regions and a wider group of players. We're continuing to work on polishing the game as we drive towards open beta testing.

Rounding out our big announcements since the last call is the name change of Blizzard All-Stars to Heroes of the Storm, which is our take on free-to-play hero brawlers. We've done an extensive internal test on Heroes over the past several months, and as the game has evolved, we felt it was appropriate to change the name to something more fitting of the gameplay experience.

We're looking forward to sharing more details about Heroes at BlizzCon, which is taking place this weekend at the Anaheim Convention Center. This is another sold-out show, with more than 20,000 attendees coming to Anaheim from more than 40 different countries.

Our global community will also follow along through DIRECTV, online pay-per-view on blizzcon.com and partner broadcast in other regions. We'll be showcasing our biggest pipeline of games ever and showing our appreciation for our community through contests, meet-and-greets and of course, major eSports spectacles. The World of Warcraft Arena invitational and the global grand finals of the StarCraft II World Championship Series will be taking place, along with an invitational tournament for Hearthstone, featuring popular community personalities.

All of us at Blizzard can't wait to get back to BlizzCon and connect with our players. We hope you'll join us there or follow along online with a virtual ticket available online at blizzcon.com. We're looking forward to celebrating a shared passion of gaming with our players, hearing their feedback on our newest game content and taking that energy and knowledge back to work as we drive toward an exciting 2014 for Blizzard.

Thanks, and I'll turn the call back over to Kristin.

Kristin Mulvihill Southey

Thanks, Mike. Operator, I think we'll open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Brian Pitz of Jefferies.

Brian J. Pitz - Jefferies LLC, Research Division

I know we have to wait through the holiday to get a better sense for Skylanders' performance. Can you give us an idea for how the SWAP Force launch compared to Spyro's or to Giants maybe in terms of things like character tie ratios? And then really quickly, are you seeing a big difference for the -- in terms of developing and delivering on the different consoles, the next-gens? There's a lot of discussion right now around -- noise around native versus upscale 1080p. Is that something that really differentiates a platform, or can that be improved as your hardware partners do software updates that rejigger the -- and free up resources, GPU, memory, et cetera?

Eric Hirshberg

I'll take both of those. First of all, on SWAP Force, as we've noted throughout the year, this is a year unlike past years, when we've launched games like Spyro's Adventure and Giants. And what we're seeing for SWAP Force this year is that some markets are down, some markets are up. Overall, we're down, which is not unexpected. The 2 main issues here is that we've invented a category 2 years ago, and for the past few years, we've had a competitive landscape completely to ourselves. This year, we've had 2 major competitors, with both Disney and Pokemon launching the day before us, as you guys know. And second, Skylanders is also not immune to the effects of the console transition year. In fact, our quantitative research has shown that this is one of the top reasons that parents who've shown an intent to purchase the game are hesitating. But there are a couple of things that are important to remember. One is the vast majority of our sales historically on this franchise have come in November and December, ramping up towards the holiday. Two is that we have a great game, the best game in the franchise's history. Three is that toy attach is as strong as ever. And four is that awareness and purchase intent are also as strong as ever. So we're staying in the pocket, looking forward to a great holiday. On the second question you asked related to the console, that's really a better question for the first parties since they've taken different approaches to the design of the hardware and have different allocations for processing power that are available to developers. And the issue you're raising has been consistent across multiple games in similar genres to ours. What I can assure you is that we've worked hard to maximize the performance on each and every platform that we've release the game on and that we think we have the next-gen launch title being Call of Duty: Ghosts.

Operator

Our next question comes from Colin Sebastian, Robert Baird & Co.

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

Great. I guess curious now that the transaction is behind you, I'm wondering how you're approaching further development plans and customer support, Mike, for World of Warcraft just given the changing mix of the user base towards Western markets. And with the content update, I'm wondering if you could provide a little more color on what the distribution of the users are geographically?

Michael Morhaime

Well, in the last quarter, the user base has been pretty stable. I think that the way we're viewing customer service for WoW, of course, we want to maintain a high quality of service to our players, but I think we want to continue to look at more efficient and better ways of doing that. And so there are a lot of efforts going towards improving customer self-help so that our millions of players don't actually have to contact us directly. But in terms of the content and developing, we have more resources focused on developing content for World of Warcraft than ever before. So we expect to continue having a long and happy life.

Operator

Our next question comes from Doug Creutz of Cowen and Company.

Douglas Creutz - Cowen and Company, LLC, Research Division

Your MMO costs of goods sold was down roughly significantly quarter-over-quarter. Was there some permanent cost reductions that might have happened that are driving that or was that just more of a normal fluctuation?

Dennis Durkin

Yes, I'll take that. I mean, cost of goods sold can vary based on our mix in any one quarter, and so I wouldn't use that as sort of a long-term guidance. I think we're always looking across the capitals -- or across our expense base to drive efficiencies, but it's more the cost cash base [ph] than anything. So I'd just look at our forward guidance as the best barometer for what's to come relative to that. Obviously, Skylanders mix has a big play relative to overall cost of goods sold because of the...

Douglas Creutz - Cowen and Company, LLC, Research Division

I was referring specifically to the MMO line item.

Dennis Durkin

Oh, okay. I'm sorry. We brought the MMO line item relative to the cost reduction and the savings that we've seen. I mean, it's kind of tied to the previous question, where we've actually been more efficient over time with -- in terms of driving cost out of our online operations and our customer service. It relates very much to what Mike's talked about before in terms of self-help and getting more efficient with that. And I think the team's done a great job of embracing new goals to become better at that over time. So I think that's certainly -- we think about optimizing our efficiency. That's an area across -- not only the Blizzard side but the Activision Publishing side that we're very focused on.

Operator

Our next question comes from Avi Steiner of JPMorgan.

Avi Steiner - JP Morgan Chase & Co, Research Division

Given the recent change in ownership, how should investors think about the pace of new game introductions, the international opportunities? And just related to that, any updated thoughts on maybe bringing some cash back?

Robert A. Kotick

Yes, the benefit that we have now of not having a majority shareholder is operating independence, but that won't change the overall strategy of the company. We're continuing to be focused on investing in our franchises, building out new franchises, expanding new geographies, prioritizing our investments towards the greatest opportunities for the benefit of our shareholders.

Operator

Our next question comes from Edward Williams of BMO Capital Markets.

Edward S. Williams - BMO Capital Markets U.S.

A couple of questions. First of all, Eric, can you just kind of go back to Call of Duty and what your expectations are for kind of downloadable content as in the early stages of the game, looking at this year versus prior iterations of it? And then Bobby, just curious if you can comment a little bit about looking at the next platform cycle, having gone through a number of these cycles in the past, what your thoughts are as far as the early adoption is concerned for those cycles and what we could see with attach rates and the like?

Eric Hirshberg

On the first one, it's too soon to tell. It depends on a lot of other factors. But I can tell you what we know so far. So far, attach rate on things like Season Pass has been very strong, and we're also seeing longer average session length so far, meaning more engagement with the players, with the millions of players who are already online enjoying the game. Historically, more engagement has meant better monetization over time because people are more engaged and more willing to do things like purchase DLC or purchase micro DLC or purchase a Season Pass. So we're pleased by those longer average engagement times. We also -- we're thinking ahead when we developed our third mode with Extinction. And obviously, we've seen how that third mode can play a big role in a long tail on a rich DLC season, and so you'll see a great slate of content coming our players' way in the wake of Ghosts, including a lot of Extinction content, so we'll have a fantastic season to look forward to.

Robert A. Kotick

And with respect to the introduction of new the hardware, you know this almost better than anybody, but you've got 2 laser-focused large companies who have important future benefits that come from continued investment against the successful launch of these platforms. They've made more investments in the back office than ever before. I think you've got lots of efficiencies in manufacturing cost that can potentially drive hardware pricing down sooner in the cycle. But there's no indication from our perspective that you're going to see anything other than a very successful next 7 or 8 years.

Operator

Our last question comes from Eric Sheridan of UBS.

Eric James Sheridan - UBS Investment Bank, Research Division

Longer term, now that the transaction's closed, maybe an update on how you think about the right level of leverage for the company, coupled with how you're thinking about shareholder returns in general and sort of balancing the 2 on a going-forward basis.

Dennis Durkin

Sure. I'll take that one. This is Dennis. Thanks, Eric. Obviously, we're very comfortable with the level of debt that we took on as part of this transaction and sort of the cash flow generation that we have. We have a culture that's been very focused on cash generation, so it's not really a big change for us relative to sort of driving that. Going forward, debt service and sort of paying the amortization on the term loan will be our primary focus obviously. But as we've done every year and as we do every year, once we have visibility into how the holidays landed and how our annual operating plan looks, we'll make new capital allocation decisions in our January board meeting, and we'll talk more about that going forward. Frankly, we're very comfortable with the levels of debt that we have and the service ratios that we have to service that over time.

Operator

And this does conclude our Q&A session. I'd like to return the conference back to Kristin Southey for any concluding remarks.

Kristin Mulvihill Southey

Well, on behalf of everyone at Activision Blizzard, I want to thank you for your time and consideration. And hopefully, we'll see a lot of you at BlizzCon on Friday. So thank you.

Operator

This does conclude our conference call for today. You may now disconnect your lines. And everyone, have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Activision Blizzard Management Discusses Q3 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts